Remember the trumpeted financial reform bill that Congress passed in late July? You know the one, the new round of regulations that would abolish greed, protect us from Wall Street, the slap-on-the-wrist political payback for the bailouts, the kind of major legislation that results in hours of cable news face time for politicians standing in front of too many flags.
Not noticed among all of the pomp surrounding the law’s passage was a small provision within it pertaining to, oddly enough, state landlord-tenant law. Congress must have calculated that, while it was burdening even the most honest financial institutions with new regulations, it would be “germane” to take a shot at the real estate investor as well.
Whether the “financial reform” law delivers on all the windy promises or, more likely, is just another set of expensive regulatory and compliance headaches for law abiding firms that didn’t get bailout money, will have to await a future article. Tucked away inside the bill, however, and germane to this article, was an amendment to President Obama’s Protecting Tenants At Foreclosure Act.
If you read my June 15, 2010 post, I wrote about the Act at length. One of my criticisms was that the Act failed to define “Notice of Foreclosure”, a critical term for deciding whether a real estate investor at foreclosure purchased a tenant-occupied property subject to the tenant’s existing term lease. Prior to the Obama law, the answer was nearly always “no”, the new investor bought the property free and clear of all junior encumbrances, including leases, which were extinguished by the foreclosure sale.
Thus, the new investor knew when bidding that he could buy a tenant-occupied property and “flip” it, i.e. fix it up and offer a renovated and vacant property to the market in short order. Because “flippers” sell their properties at fire sale prices, the new family coming in could often times obtain the property with equity already in it. It is from this process of fresh investment and profitable transactions that the real estate market digs itself out of a recessionary hole with the resulting appreciation in values being a tide that lifts everyone’s boat.
Under pre-Obama law, the new investor had no reason to be concerned about tenant occupancy because he knew that the foreclosure sale wiped out the lease. Obama’s blow-hard Protecting Tenants At Foreclosure Act changed that. Now, a real estate investor buys at foreclosure subject to any existing term lease. (All other leases require a needlessly long 90-day notice to terminate).
Thus, if a tenant has a term lease with ten months remaining on it at the time of foreclosure, the tenant gets to stay for that ten months even if the lease came after the deed of trust foreclosed upon. In other words, the real estate investor is stuck. He has no way of knowing prior to the foreclosure sale whether the tenant has a month-to-month lease requiring a 90-day notice to terminate or a term lease with God knows how much time left on it.
The result is that investors will pass on tenant-occupied properties leaving the bank to credit bid and add to its glut of inventory of foreclosed properties or investors will lower their bids to take into account the investment uncertainty. Either way, the law’s result is the same, it slows recovery by either keeping fresh money out of the foreclosure process or it contributes to downward pressure on the real estate market because foreclosed properties will not realize their full bid potential. The law was completely unnecessary-and nothing more than political window dressing and pandering to the more numerous tenant voter-because existing state law already adequately protected the rights of tenants.
Back to the language of the Obama law. Whether a term lease survived foreclosure depended upon whether it was entered into before “Notice of the Foreclosure”. However, Congress failed to define “Notice of Foreclosure” in the original text of the law. Congress fixed-for lack of a better word-that problem in the financial reform bill on July 21, 2010.
The term “Notice of Foreclosure” was critical to the law’s reach. If Congress defined “Notice of Foreclosure” to mean earlier in the foreclosure process, i.e. closer to the underlying default by the prior property owner, such definition would better serve the real estate investor since it would mean that fewer term leases would qualify and, as to those that did, less time would remain on them after foreclosure.
If, however, Congress defined “Notice of Foreclosure” further out, say closer to the actual foreclosure sale, such definition would be better for tenants because it would bring more term leases within the ambit of the law and such leases would likely have more time left on them after the foreclosure.
Would anyone like to guess which option Congress and the President chose? You guessed it. Congress chose the latter, determining in the fictional world of politics that the tenant does not get “Notice of Foreclosure” until the moment of the actual foreclosure sale.
In reality, the tenant knows about the foreclosure months before the sale. Also, the tenant doesn’t get notice of the foreclosure at the time of the property’s auction since the tenant isn’t present for it. Thus, Congress chose to define “Notice of Foreclosure” at the very instant in time where the tenant doesn’t get notice of the foreclosure. Since the law was political from its inception, however, it shouldn’t be surprising that logic and fact as considerations finished dead last in its wording. The effect of the Notice of Foreclosure definition is that any term lease entered into before the moment that the trustee bangs his gavel is enforceable against the new investor and the property is burdened with it.
Congress didn’t bother to clarify the more looming ambiguity in the law, namely, whether the tenant with a month-to-month lease must pay rent during the 90-day notice period required to terminate his tenancy. Since the law is a political sop for the tenant voter base, it follows that the law won’t even pretend to be fair to real estate investors. After all, Congress and the President instructing tenants to pay rent would ruin the political ambitions of the Obama law.